Educational Articles

America’s Lost Generation?

Bryan J. Fong
| October 02, 2011

The current economic situation in the United States is difficult to say the least. With unemployment above 9%, (the real figure, when taking into account discouraged persons and those who are working part time or on a temporary basis is closer to 18%). Meanwhile, a continued easing of the money supply and near-zero interest rates have done little to spark a recovery. The quantitative easing programs designed to pump extra funds into the economy and drive growth, appear to have done little more than inflate equity prices. And to that end, at its current level, the S&P 500 Index has given back just about all of the gains since the formulation of QE2 a year ago. Will the prospect and potential implementation of QE3 be the necessary cure for our economic woes? Or will our economy and the stock market need to bottom out, before an uneven recovery can give way to a sustainable and inclusive business rebound?

We may be able to garner some insight from Japan’s economic situation spanning from the late 1980s through the late 1990s. Throughout the 1980s, Japan’s real estate market became greatly overvalued. At one point, the highest recorded square footage amount was around $93,000 (USD). In the fall of 1989, that real estate bubble burst. This gave way to the realization that many of the Japanese banks had done little due diligence before deciding to underwrite mortgages on properties with inflated prices. Once these flawed underwriting principles were brought to light, many of the stocks attached to the companies involved fell sharply. This caused a full-fledged domino effect with regard to Japanese equities, and from 1990 to mid 1992, the Nikkei 225 declined by approximately 65%. Meanwhile, by 2001, land values in Japan had declined by roughly 70%. In an effort to reverse the downturn in asset prices, the Bank of Japan dropped interest rates to zero. The thought process being, that an easy monetary policy would pump extra yen into the economy and people would continue to spend and invest in the financial markets as well as in real estate. Unfortunately, the unnecessarily low interest rates resulted in a liquidity trap. This is where investors and businesses decide to hold onto cash in anticipation of lean years ahead. And consequently, a credit crunch ensued. Many banks needed to be subsidized by the government, turning them into so-called zombie banks that were not lending money. In turn, Japan’s economy slowed and its gross domestic product (GDP) growth plunged from a high of 10% in the 1960s, and 4% in the 1970s and 1980s, to just 1.5% for the bulk of the 1990s. This caused many Japanese companies to reevaluate their near-term plans for expansion, and general hiring, both of which fell drastically.

As a result of an entire decade of little-to-no economic growth, many graduates during that time frame were unable to find employment in their respective fields of study. Some went on to find jobs for which they were overqualified others found they did not have the requisite education. Still, others were unable to find work and are living with their parents today. This has caused serious problems of throughout this generation. Also of note, Japan has a history of lifetime employment, company men, as they are known, in which an individual spends his/her entire life with one employer. Once the economy began to improve, many companies decided to hire from the more recent graduates, rather than to pull from the outdated supply that had been lingering for five or even ten years without employment. These problems have eased quite a bit over the years, but some believe that the lost generation spans from the late 1980s until the mid-2000s.

Now fast forward a few years and set your sights on the United States. During the mid-1990s, the United State’s median home price began to rise at an increasing rate. In the early 2000s, multiple economists identified the domestic housing market as an asset bubble. This trend continued through 2007, when home prices peaked and the bubble eventually burst. Following the downturn in real estate prices, many home owners ended up being under water on their mortgages. Many were forced into foreclosures and so-called short sales, while others just realized that it would be easier to lose the property and start over, rather than to continue to pay down a monthly mortgage on a property that was not worth nearly as much as they had originally paid for it.

Primary issues here were subprime mortgages, teaser rate loans, and predatory lending. Many people bought homes that were outside of their price range thanks to interest only loans. They were under the impression that they could refinance the mortgage after a year or so and before the teaser interest rate expired. Assuming the property advanced roughly 20% in value during that time frame, they would then have adequate equity to qualify for a more favorable/conventional mortgage. This practice worked well for a time, until home prices stopped advancing at such an unsustainable clip. When the price of the underlying assets depreciated, and the teaser interest rate period was over, many homeowners were unable to continue making payments. This trend caused a massive devaluation in real estate prices. From May of 2007 to January of 2009 alone, the average sales price for new homes declined more than 25%. And in many parts of our country, real estate prices could fall still further.

Meanwhile, thanks to the securitization process, many of these subprime mortgages were bundled together as a group of assets and sold off as collateralized debt obligations or CDOs. Years ago it was realized that by grouping a large basket of higher-yielding risky assets together, one could receive a superior return in excess of what would be received on a basket of AAA-rated securities. A similar process occurred in the 1980s only the investment vehicle of choice back then was the mortgaged backed security (MBS’s) and it was the U.S. savings and loan companies that were brought to the brink of destruction. Through the securitization process some of the risk can be diversified away. However, that assumes a certain level of quality control is in place. The real estate boom even spawned NINJA loans (No Income No Job or Assets), meaning the originating bank would give you a mortgage without verifying any of these items. Back when banks held onto the mortgages, pre-securitization boom, they may have held onto a loan for its entire term of 30 years. Clearly, it was in their best interest to fully vet the solvency of a potential home owner. But, post-securitization boom, banks knew they would send all of their mortgages away and the liability would be transferred off their books. Thus underwriting standards continued to fall, and people who would normally not qualify for a loan were getting them on properties they really couldn’t afford.

Once the financial house of cards started to fall, banks began to tighten lending standards and even perfectly legitimate home buyers were turned away. With an oversupply of homes on the market and few buyers in sight, real estate values continued to tumble. The massive write downs on CDOs and other mortgaged-backed securities that were held by many banks both on- and off-balance sheet resulted in the collapse of Lehman Brothers and Bear Stearns, just to highlight two once-proud names. Other banks had to receive large capital infusions from the government just to stay solvent. This caused major stock market turmoil, and the broader market indices declined precipitously. From October 2007 to March of 2009, the S&P 500 Index plunged by some 60%.

The decline in the financial markets and the coincident credit crunch has caused many U.S. businesses to reevaluate their need for expansion. This has only been exacerbated by the slowdown in the global economy. As a result, many companies have laid off a large percentage of their workers and cut costs wherever possible in an effort to bolster the bottom line. This may work in the short term, but without eventual growth in the top line, this practice will not sustainably add to earnings. Companies have recognized this, and have opted to hire part time or contract workers for jobs that were previously handled by full timers as a means to side step the need to pay employee benefits. Many recent graduates are having difficulty finding suitable employment opportunities within their fields as was the case in Japan earlier. In fact, some schools are even being investigated for inflating their job-placement statistics in an effort to entice students. A few law schools have included students in their placement percentage when that graduate is working at Starbucks let’s say, a job that will not likely cover the large debt that goes along with law school tuition. Meanwhile, the Federal Reserve has continued to keep interest rates at historic lows, as a means, it hopes to spur an economic recovery. Add to this, two rounds of quantitative easing, with a potential third round on the way. Still, there is no assurance we will not again succumb to recession, or at the very least a prolonged period of very subpar GDP growth.

In sum, asset bubbles and successive collapses, as well as rising unemployment have been the norm for much of this century thus far. Meanwhile, new graduates have faced a difficult job market for at least five years. Although lifetime employment is not representative of our business culture, as it was in Japan, and it is possible for employees to make a career change after a time, it is certainly easy to see the correlation between the events that occurred in Japan and those happening right now in the United States.

The most recent employment report stated that total unemployed people including those marginally attached to the labor force and those that are employed part time for economic reasons is currently as high as 18%. That is a disconcerting metric to say the least. Based on our population growth, we need as much as 200,000 new jobs added each month just to keep pace with new entrants into the labor force. And as a general rule, our GDP growth needs to hover around 3%, or more, to provide that level of job creation. However, recent data from the U.S. Department of Commerce, Bureau of Economic Analysis lists first quarter GDP at 0.4% (this figure was revised down from 1.3%). The revised results for the second quarter of 2011 are 1.3% (this figure was raised from 1.0%). This is a far cry from the normalized rates of growth in the formative stages of a recovery when job growth is usually strong.

What does all this mean for the portion our population that could potentially fall into the lost generation? Those in the age range of 25 to 34 years old have an unemployment rate of 9.5%, only marginally higher than the overall unemployment figure of 9.1%. By far the largest demographic is the 16- to 17-year olds weighing in at 29.6%, while 18- to 19-year olds were a close second, registering a rate of 24.5%. While these figures are quite high, they represent the portion of our population with little or no college education. As such, we would expect them to be a markedly inflated during an economic downturn. So what about the age group that presumably has a college degree, ages 20 to 24? They have an unemployment rate of 14.8%. Depending on how long this delayed entry into the workforce lasts, it is a reasonable assumption that this group, as a whole, will have a lower earnings capacity than groups that hit the ground running, fresh out of college, in better economic times. So when 2020 or 2025 rolls around, will we be discussing our lost generation and how it could have been avoided? It certainly looks like we could head in that direction. Time will tell.

At the time of this article’s writing, the author did not have positions in any of the companies listed.